Investment Risk is the chance of losing some or all of your invested money due to the price volatility of your investment. In the investment universe, there is an interesting relationship between risk and return, and a clear understanding of this will help an investor make an informed investment decision. The rule of thumb avers that high-risk investments have a high potential of high returns whereas low-risk investments are most likely to yield low returns. The implication is that, high risk is associated with high returns.
The risk/return tradeoff is thus the balance between the desire for the lowest possible risk and the highest possible return. It is worth noting, however, that high risk does not necessarily translate into high returns. High risk could potentially pay off with losses depending on the market forces at play at a particular time(T). This is why it is very important to decide what level of risk you can take as an investor in choosing an investment instrument.
One of the most important factors to consider before investing is your risk-return profile generally and particularly of the investment being courted. Some investors look out for investment instruments that guarantee safety (near zero risks), and at the same time promise competitive returns. Others are not so bothered about the ‘safety’ of their principal and or the return on investment if only they are compensated with very high returns.
Knowing your risk-return appetite and the risk profile (potential risk) of the investment instrument you purchase helps you to take the right risk decision. Howbeit, the best an investor can do will be to minimize/manage the investment risk as investment risk can never be zero on any investment instrument.
Managing / Minimizing Investment Risks
Managing investment risk does not only address the avoidance of risk but also the ability to achieve zero to minimal losses. Furthermore, your knowledge of the type of risk you can be confronted with, the ones you may take voluntarily, and the ones that may catch you unawares is equally important. That leads us to your ability to prioritize risk.
Some risks have a higher impact than others and thus may need more attention because they cause the biggest losses or gains. Let us take a look at some risk types and how to handle same so we are guided in prioritizing
- Inflation risk: When inflation rises fast relatively, its impact on investment is that it erodes the purchasing power of invested assets and the investor is left with lesser monetary value.
- Interest Rate Risk: Interest rates could rise or fall. Interest rate fluctuations control the value of bonds and any investment in fixed yield vehicles is vulnerable to interest rate changes. Unlike changes in the direction of the stock market, changes in interest rates could come with some forewarning.
- Time Risk: Time can be your friend or foe. Investors holding individual stocks for extended periods face the risk that the company they are invested in could enter a state of permanent decline or go bankrupt. Even a portfolio of stocks can result in negative returns. This accounts for the risky nature of stocks even over the long-term. Though they promise greater returns the longer you hold them, they don’t get safer.
- Taxation Risk: Returns on stocks are taxed when being paid out. An investment is tax-effective if you end up paying less tax than you would have paid on another investment with the same return and risk. Controlling taxes, which can be done using qualified annuities and retirement plans, enables your earnings to compound unimpeded by taxes so they can grow faster.
- Market Risk: The possibility of experiencing losses due to factors that affect the overall performance of the financial markets (e.g., the stock market). Market risk, also called “systematic risk,” cannot be eliminated through diversification, though it can be hedged against in other ways.
In conclusion, your ability to manage any type of risk associated with your investment decision is your responsibility. Never go to bed on your responsibility of knowing whatever risk is associated with any investment decision you take. If you do, then you take responsibility for its consequence.
Take responsibility thus by;
- Monitoring your investments
Make sure you ask questions about what your money is invested in and monitor your portfolio’s performance. This can help you understand and manage the risks of your investments and ensure your overall investment goals are on track. If necessary, you may need to rebalance your portfolio from time to time (in consultation with your investment manager) so it remains in line with your risk profile.
- Beware of scams
When markets are volatile, scammers try to take advantage of investors. Investment scams can be so professional and believable that it becomes hard to tell. Some signs to look out for include: withdrawal delays, mistakes on investment balances, return guarantees and extremely high returns. You may also want to check published statements, compare expected returns with similar instruments, and be sure to deal with only licensed investment advisors.